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Not Keen on Keynes

The U.S. economy is in recession, and federal policymakers want to help by applying some old-fashioned Keynesian medicine. They are considering a stimulus bill of up to $700 billion, with substantial spending going to state and local governments for infrastructure and other activities. But such a grab-bag for the states is ill-advised for ten good reasons, at least.

1. THE FEDERAL GOVERNMENT IS BROKE.
The feds already face a $1-trillion deficit this year and massive red ink down the road from Social Security and Medicare. It cannot afford a state bailout — and indeed, should be trimming some of the 800 current state-aid programs in order to balance its own budget.

2. SPENDING IS THE PROBLEM.
Rapid spending growth has pushed many state budgets into deficit. Total state and local spending rose 7.6 percent in 2007 and a further 7.0 percent in 2008, based on three quarters of data. The federal government should not facilitate the states’ spendthrift ways.

3. A KEYNESIAN STIMULUS IGNORES THE LONG RUN.
Economists in the Keynesian tradition believe that government spending spurs short-run economic growth. Economists in the monetarist tradition believe that any such positive effects would be short-lived. Yet other economists in the “rational expectations” tradition argue that a Keynesian stimulus would have no effect at all on output.

In truth, economists do not have an accurate or agreed-upon model of the short-run economy, and their advice is often in error. Politicians should be more humble about their ability to control short-term economic ups and downs. Legislative action based on incomplete information risks destabilizing the economy further. Efforts to fix short-term problems often create long-term damage — such as by putting the nation further into debt.

4. RISING FEDERAL DEBT IS FISCAL CHILD ABUSE.
Spending on a stimulus package would be funded by additional government borrowing. The burden of that borrowing would fall on young people and future taxpayers. Federal policymakers are leaving a terrible fiscal legacy to the next generation, and a stimulus package would only make matters worse.

5. A BAILOUT WOULD FLOUT STATE FISCAL TRADITIONS.
Nearly all the states have statutory or constitutional restrictions on budget deficits and government debt levels. Many of those restrictions were put in place a century ago so that politicians would live within the “allowance” taxpayers provided them. A federal bailout of the states goes against the spirit of those state fiscal traditions, which were designed to encourage restraint.

6. A BAILOUT MAY DELAY STATE REFORMS.
Many states have short-term budget gaps, but face a larger fiscal crisis from long-term spending promises. State and local governments have unfunded obligations in their pension and retiree health care plans of at least $2 trillion. Adding to state fiscal woes is rapidly rising Medicaid spending.

7. STATE INFRASTRUCTURE IS ADEQUATELY FUNDED.
Despite complaints that “our highways are crumbling,” state spending on infrastructure has been at fairly high levels in recent years. State and local gross capital investment has averaged 2.4 percent of gross domestic product this decade, which is higher than in the 1980s and 1990s. If states need more investment in highways and airports, they should look to private financing, as many foreign governments have done.

8. STATE SITUATIONS VARY.
While some states have large budget gaps, more than a dozen states do not — and don’t need help from Washington. If only the states with the big deficits are bailed out, it would be unfair to the states that have been better managed.

9. BAILOUTS BEGET MORE BAILOUTS.
If state politicians know that they will be bailed out by the federal government when they get into trouble, they will be more likely to make irresponsible choices that produce another fiscal crunch. Bailouts of state governments and the automobile firms would likely lead to a longer line of handout seekers on the steps of the White House and Capitol.

10. A BAILOUT SHIFTS ATTENTION FROM NEEDED FEDERAL REFORMS.
Federal policymakers should resist the impulse to try and manipulate short-run growth. Instead, Congress and the new administration should put their time and efforts into policy reforms to foster long-term growth and fiscal stability, such as business tax reforms and entitlement program reforms.